Ask the Probate Judge—Capital Gains on Residences
Rudd, appeared August 14, 2003, Albuquerque Journal, Business Outlook
Reprinted with permission
Editor's note: This column may not be quoted or reproduced in whole or part without express written permission of the author.
Q: Your column of July 17 mentioned a two-year residence rule relating to capital gains tax law. Could you refresh this reader's memory on the topic of capital gains on home sales?
Remember when new homes cost $10,000? Perhaps a home you paid $10,000 for in 1954 is now worth $200,000. If you made no improvements to the home and sold it, you could realize a $190,000 capital gain. Normally, capital gains are reported on income tax returns, but the IRS generously provides an exception for home sales.
A taxpayer may exclude from gross income up to $250,000 of gain from the sale or exchange of the taxpayer's principle residence. With limited exceptions, the homeowner must own and use the home for at least two of the five years before the sale. A vacant parcel of land next to the principal residence may qualify for the exclusion if the land is used as part of the residence and is sold within two years before or after the sale of the principal residence.
A taxpayer's principle residence can be determined by examining factors such as place of employment, tax return address, driver's license, voter and auto registrations, and mailing address. Short, temporary absences such as vacations count as periods of use.
Married couples filing jointly for the year of the sale can exclude up to $500,000 of home-sale gain if certain conditions are met. In the case of unmarried joint owners, according to recent IRS tax regulations, each taxpayer may be allowed to exclude up to $250,000 of gain.
Capital gains exclusions on home sales used to be tied to age; people 55 or older could benefit. Under current tax law, however, homeowners of any age can use the capital gains exclusion rules for home sales.
The former tax law allowed a "once in a lifetime" capital gains exemption. The current law says homeowners can use the capital gains exclusion rule once every two years.
Suppose two people plan to marry. Each has owned and lived in a home for two of the past five years. If they sell their homes prior to marriage, they can each use the $250,000 capital gains exclusion. Then they can marry, buy a new principal residence jointly, and live there at least two years. If they meet IRS conditions, they can sell the new home after two years, exclude up to $500,000 of capital gain, and buy another home. And so on. Current law bestows more benefits to homeowners than prior law.
The current law applies to homes sold after May 6, 1997. IRS Publication 523 provides more details; get it free through the mail by calling 1-800-829-3676. Or visit the IRS office in Albuquerque at 5338 Montgomery NE for a variety of free informational brochures and tax forms.
© 2003, Merri Rudd & Albuquerque Journal, All Rights Reserved